What does the term “Zero cash flow property” imply?
Nowadays, the popularity of Zero Cash Flow Property NNN investments – leasehold or fee simple – is rapidly increasing amongst commercial real estate investors all over the globe. As the name suggests, “zero cash flow property” or “zeros” refers to the fact that the investor – in such a flow NNN Lease Property – does not receive any cash flow of income from the property until the underlying loan matures in full. In simple words, the loan payment on the investment property is equal to the net operating income of the property, hence “zero cash flow”. In such investment properties, the net operating income directly assigns to the lender to pay off debt taken on to purchase the property. Zero cash flow property is usually highly leveraged with a long term lease (at least 20 years) secured by the investment grade credit rating of a tenant.
Although, prime facie, a zero cash flow property might not look lucrative to investors, there are circumstances and reasons where such an investment makes eminent sense:
- Use as 1031 & 1033 Exchange property: The most striking advantage of Zero Cash Flow Property is that you can utilize them as 1031 (& 1033) Exchange property. A 1031 Exchange allows investors to defer capital gains and recapture taxes after the sale of foreclosure or highly leveraged assets by reinvesting the capital gains in any highly leveraged assets like a Zero cash flow NNN lease.
- Highly Predictable investment: The debt financing in zero cash property is non-recourse, predictable, fixed rate and conventionally amortizes over a term that can be shorter than the underlying lease term.
- Low equity, High Leverage investment: Investors usually purchase a zero cash NNN lease property with equity as low as 10% – 15% of the net value of the asset.
- Phantom income and tax: Zeros produce phantom income when the principal being paid down on the debt exceeds the deductions for depreciation and interest. This typically starts in years 15 -16 and is paid for with inflation-adjusted dollars (historically $.58 on the dollar). To accurately calculate the amount of phantom income, the basis and deprecation from the relinquished property must also be used. Because leaseholds can be 100% depreciated they have less potential phantom income vs fee simple zeros, when the loan principal pay down starts to exceed the interest and depreciation deductions.
- Residual value: When the lease term expires and debt is fully amortized, the landlord investor gets to benefit from secure cash flow and enhanced residual value.
- 1031 One time Pay Down Re-Advance facility: The pay down re-advance facility found in many zeros allows 1031 investors to satisfy their exchange requirement for replacement property then, post-closing, allows them easily and with no additional cost, take up to 92% of their cash out of the property for other uses. To use the pay down re-advance facility, investors need to post a refundable deposit with the lender with non-exchange dollars.
- Short Closes: Close times can be as short as ten days, further making zero cash flow property appealing for time sensitive situations.
However, in the world of commercial real estate, the term “perfect” investment is a myth. The kind of commercial real estate property investment that is “best” for an investor is one that is consistent with your risk tolerance and investment goals. Therefore, call your trusted commercial real estate NNN brokers and experts at Triple Net Investment Group! We can help you evaluate prospective zero cash flow property and significantly minimize risks.
